Wealth may call for less risk, Of Dollars and Data argues

Retail investors often hear that a bigger net worth gives them more room to take chances. Of Dollars and Data argues the opposite can be the more rational move: as wealth rises, preserving what you have can become more valuable than reaching for another step up.

The personal finance site calls the idea the “Risk-Wealth Paradox.” The argument starts with a simple point from the site’s discussion of The Wealth Ladder: people do not experience every dollar the same way. The first $10,000 can change a person’s life more than the next $10,000, and the first $1 million can matter more than the next $1 million.

Why more money can change the risk equation

Of Dollars and Data says wealth creates a “lifestyle floor,” meaning a standard of living people become reluctant to give up after reaching it. Someone who no longer worries about grocery prices may place a high value on staying in that position.

The site also argues that each higher level of lifestyle can become much more expensive than the last. Moving from a bus or train to a plane may cost 1.5 to 2 times more, depending on the trip. Moving from first class to private flying can cost 10 times more, according to the analysis.

That cost curve matters because a larger portfolio may be needed to produce what feels like a meaningful lifestyle improvement. Of Dollars and Data says that means investors who are already close to the life they want may have less reason to keep taking large risks.

The essay distinguishes ability from desirability. A wealthier person may be able to withstand a bigger dollar loss and still cover basic needs. But if that person is already satisfied with a commercial-flight lifestyle in what the site labels Level 4, or $1 million to $10 million, the incentive to chase Level 5, or $10 million to $100 million, may be lower unless private flying or similar upgrades are part of the goal.

Losses can hurt more as portfolios grow

The analysis connects the idea to prospect theory, a behavioral economics concept that says people usually feel losses more intensely than equal-sized gains. In plain English: losing $100 often feels worse than gaining $100 feels good.

Of Dollars and Data says that effect can become more pronounced as wealth rises. In its example, someone with a $2 million net worth may feel the pain of losing $1 million far more than the pleasure of gaining another $1 million. The site notes that the exact numbers vary by person.

Recovery time is the second part of the argument. A person who loses $1,000 in a brokerage account may be able to earn that back quickly. A $100,000 loss in a retirement account could take years to rebuild.

The gap widens when portfolios grow faster than income. Of Dollars and Data gives this example: if someone saves $50,000 a year, replacing a 20% loss on a $1 million portfolio would take under four years, assuming a 5% return. Replacing a 20% loss on a $5 million portfolio would take more than 14 years under the same assumptions.

The “risk squeeze”

The site calls the combined pressure the “risk squeeze.” It says three forces can reduce an investor’s appetite for risk over time: age, liabilities and wealth. Liabilities are financial obligations, such as supporting children or aging parents.

The author says his own allocation has changed over time, from 15% in U.S. bonds, to 0% for several years, and now to 20% in U.S. bonds, with more Treasury bills and tax-free municipal bonds set aside for a future home purchase.

He does not present that allocation as a model for others. The broader point from Of Dollars and Data is that risk tolerance is personal and should be weighed against goals, obligations and how long it would take to recover from a setback.

This story draws on original reporting from Of Dollars and Data.